III. EXPLANATION OF ADDITIONAL COMMITTEE AMENDMENT TO H.R. 10612, AS REPORTED

A. TITLE XXII-ESTATE AND GIFT TAXES

1. Allowance of Credit Against Estate Tax (sec. 2201(a) of the bill and sec. 2010 of the Code)

Present law

Under present law, the estate of each decedent who was a resident or a citizen is entitled to an exemption of $60,000 for estate tax purposes. In the case of an estate of a nonresident alien, the exemption is $30,000.

Reasons for change

The present amount of the estate tax exemption was set in 1942. Since that date, the purchasing power of the dollar has decreased to less than one-third of its value in 1942. To some extent this effect has been mitigated by the addition of a provision for a marital deduction in 1948. Despite this the inflation which has occurred means that the estate tax now has a much broader impact than was originally contemplated.

In addition, since the present estate tax exemption is a deduction in determining the taxable estate, it results in a greater reduction at the estate's highest estate tax brackets. However, a credit in lieu of an exemption will have the effect of reducing the estate tax at the estate's lower estate tax brackets since a tax credit is applied as a dollar-fordollar reduction of the amount otherwise due. Thus, at a given level of revenue cost, a tax credit tends to confer more tax savings on smalland medium-sized estates, whereas a deduction tends to confer more tax savings on larger estates. The committee believes it would be more equitable if the exemption were replaced with a credit rather than a deduction.

Explanation of provision

The committee amendment provides for a credit in lieu of the present exemption for estate tax purposes. The amount of the credit will be $30,000 for decedents dying in 1977 and increases $5,000 each year until 1981 when the credit will be $50,000. When fully effective, the $50,000 credit is approximately equivalent to a tax exemption on the first $197,000 of the decedent's taxable estate. Thus, in 1981 an estate of $197,000 or less will be exempt from estate tax. The committee amendment also makes comparable changes in the treatment of estates of nonresident aliens.

Effective date

This amendment is effective for estates of decedents dying after December 31, 1976.

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2. Increase in Estate Tax Marital Deduction (sec. 2201(b) of the bill and sec. 2656(c) of the Code)

Prezent la

Inder present law, an estate of a decedent is granted a deduction for estate tax purposes for property pasing from the decedent to fue surviving spouse. Le maximum allowable deduction is 50 per ent of the ad, usted gros estate of the decedent. The marital dekuction generally equates the treatment of common law property with the treatment given to community property. The decedent's » are of comtauráty property passing to a spouse is not eligible for tje marital dequetion because only the decedent's share is included in the gross estate as his or her property in the first instance.

Reasons for change

The committee believes that a decedent with a small- or mediumsized estate should be able to leave sufficient property directly to the earching spouse for support during the lifetime of the spouse without the imposition of an estate tax. In addition, in practice it often is difficult to determine under present law whose efforts are responsible for the property.

Explanation of provision

The committee amendment would increase the maximum estate tax Larital deduction for property passing from the decedent to the surviving spouse to the greater of $250,000 or one-half of the decedent's adjusted gross estate. In addition, the amendment contains rules which adjust the $250,000 amount where the decedent owns community property at death so that the parity provided under present law between common law property states and community property law states is continued.

Effective date

The committee amendment is to be effective for estates of decedents dying after December 31, 1976.

3. Valuation for Purposes of the Federal Estate Tax of Certain Real Property Devoted to Farming, Woodlands, Scenic Open Spaces, and Historic Sites (sec. 2201 (c) of the bill and secs. 2032A, 6324B of the Code)

Present law

Under present law, the value of property included in the gross estate of the decedent is the fair market value of the property interest at the date of the decedent's death (or at the alternate valuation date if elected by the executor or administrator). The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. One of the most important factors used in determining the fair market value of land is the "highest and best use" to which the property can be put.

In some cases, the use of land for farming, woodlands, scenic or historical purposes may be its "highest and best use." However,

in other cases, land which is used for such purposes might be worth significantly more if it were sold and converted to other uses, such as residential or commercial purposes. Thus, where land is used for farming, woodlands, or scenic or historical purposes, the value of the land based on actual use may be substantially less than the value of the land if it were to be converted to its highest and best use.

Reasons for change

The committee believes that, when land is actually used for farming, woodlands, scenic or historic purposes (both before and after the decedent's death), it is inappropriate to value the land on the basis of its potential "highest and best use." Valuation on the basis of highest and best use rather than actual use may result in the imposition of substantially higher estate taxes. In some cases, the greater estate tax burden makes continuation of farming, etc., activities not feasible because the income potential from these activities is insufficient to service extended tax payments or loans obtained to pay the tax. Thus, the heirs may be forced to sell the land for development purposes.

On the other hand, the committee recognizes that it would be a windfall to the beneficiaries of an estate to allow such property to be valued for estate tax purposes at a value other than its highest and best use value unless the beneficiaries continue to use the property for a reasonable period as the decedent did before death. As a result, the committee amendment provides a recapture provision where the land is prematurely sold or is converted for nonqualifying purposes.

Explanation of provision

The committee amendment provides that, if certain conditions are met, the executor may elect to value qualified real property included in the decedent's gross estate on the basis of the property's value in its current use, rather than on the basis of its fair market value in its highest and best use. However, this special valuation may not reduce the value of the decedent's gross estate by more than $1 million.

Real property qualifies for this use valuation only if it is real property used for (1) farming, (2) woodland, (3) open pastoral space, or (4) the maintenance of historic values. For property to be included in the last category, it must be listed in the National Register of Historic Places either separately or as part of a listed district. To qualify for this special valuation, the following conditions must be met: (1) the assets in the decedent's estate devoted to qualifying uses, including both real property and personal property, must be at least 50 percent of the decedent's gross estate (reduced by debts); (2) at least 25 percent of the adjusted value of the gross estate must be qualified real property; (3) such property must pass to a qualified heir; and (4) the real property must have been owned by the decedent and devoted to a qualifying use for 5 years or more during the 8-year period ending with the date of the decedent's death. The term "qualified heir" means a member of the decedent's family, including his spouse, lineal descendants, parents, grandparents, and aunts and uncles of the decedent and their descendants.

In valuing qualified real property by looking solely to its qualified use, all relevant facts and circumstances are to be taken into account. However, valuation criteria which take into account a change in use.

of the real property to a nonqualifying use are to be disregarded. Thus, for example, in valuing qualified real property used as a farm, the committee intends that the following factors be taken into account:

(1) The capitalization of income that the land can be expected to yield for farming purposes over a reasonable period of time under prudent management using traditional cropping patterns for the area, taking into account soil capacity, terrain configuration, and similar factors;

(2) The capitalization of the fair rental value of the land for farming purposes;

(3) Assessed land values in a State which provides a differential or use value assessment law for farmland;

(4) Comparable sales of other farm land in the same geographical area far enough removed from a metropolitan or resort area so that nonagricultural use is not a significant factor in the sales prices; and

(5) Any other factor which fairly reflects the farm use value of the property.

The committee amendment provides that if, within 10 years after the death of the decedent, the property is disposed of to nonfamily members or ceases to be used for qualified uses,1 the tax benefits obtained by virtue of the reduced valuation are to be recaptured. The committee amendment also requires that any executor electing the special valuation provision file an agreement signed by each person who has an interest in the specially valued property, consenting to the application of the recapture provision.

Full recapture is provided for during the first 24 months with a phaseout beginning in the 25th month. The amount to be recaptured after the 24th month is 80 percent of the total tax benefit allowed because of this special valuation. Thereafter, the recapture amount so computed is reduced on a monthly pro rata basis over 96 months (8 years). However, the potential liability for recapture would cease if the qualified heir dies without having disposed of the property or converted it to a nonqualified use.

The committee amendment provides for a special lien on all qualified real property with respect to which the special valuation is elected. The lien continues until the potential for recapture is eliminated either because the tax benefit is recaptured, the qualified heir dies, or a period of 10 years from the decedent's death lapses. This new section also allows the Treasury Department to promulgate regulations under which other security can be substituted for the lien on real property. Effective date

These provisions apply to the estates of decedents dying after December 31, 1976.

1 Property ceases to be used for qualified uses not only if an actual change to a nonqualified use occurs, but also if the property is rezoned at the request of the owner to permit a nonqualifying use. In the case of property which is qualified solely because of its historic values, cessation of the qualifying use occurs if the property is removed from the National Register of Historic Places or if the owner discontinues maintenance of the historic values.

4. Extensions of Time for Payment of Estate Tax (sec. 2201(d) of the bill and secs. 6161, 6163, 6166, 6503, 6601, and 6324A of the

Code)

Present law

Generally, an estate tax return is due nine months after the decedent's death. Except in certain specified situations, payment of the estate tax is required to be made with the return.

However, present law contains two provisions which permit the estate tax to be paid over a period of up to ten years after the due date of the return. First, the Secretary of the Treasury may extend the time for payment of tax up to ten years if he finds that a current payment of the tax will result in undue hardship to the estate. Second, an executor may elect to pay the estate tax in installments over two to ten years where the estate consists largely of interests in a closely held business (or businesses).

In order to qualify under the first provision, the executor must show that the payment of the estate tax on the due date would cause undue hardship. The term "undue hardship" requires more than a showing of reasonable cause or inconvenience to the estate. In general, undue hardship can be established in a case where the assets in the gross estate which must be liquidated to pay the estate tax can only be sold at a sacrifice price. Further, undue hardship can be established where a farm or other closely held business could be sold to unrelated persons at a price equal to its fair market value, but the executor seeks an extension of time to raise other funds for the payment of the estate tax.

Under the second provision, an executor may elect to pay the estate tax attributable to an interest in a farm or other closely held business in installments over a period not to exceed 10 years. In order to qualify under this provision, the value of the interest in the closely held business must exceed 35 percent of the value of the gross estate or 50 percent of the taxable estate of the decedent. For this purpose, the term "interest in a closely held business" means an interest as sole proprietor in a trade or business; an interest as a partner in a partnership having not more than 10 partners, or in which the de-. cedent owned 20 percent or more of the capital; or ownership of stock in a corporation having not more than 10 shareholders, or in which the decedent owned 20 percent or more of the voting stock.

Under either of these provisions, the Internal Revenue Service may, if it deems it necessary, require the executor to furnish a bond for the payment of the tax in an amount not more than double the amount of the tax for which extension is granted. In addition, the executor is personally liable for the payment of the tax unless he is discharged upon payment of the tax due and upon furnishing any bond which may be required for the tax which is not presently due because of an extension of time for payment.